The liquidity ratios show a company’s ability to pay
its short-term debts by turning assets into cash. Some of the key liquidity are:
capital: Tells us how much remains after current assets has
been subtracted from current liabilities. It current assets is more than current
liabilities, then the company is efficiently being run.
ratio: measures the company’s ability to pay its current liabilities
with its current assets. It’s calculated by dividing current assets by current
turnover: measures how many times old inventory is sold, and
new inventory is brought in. A high turnover means products are being sold fast
and new products are being brought as fast, which is a good thing.
in inventory: measures how long it takes the company
to sell its inventory in a given time period. Lower is better because it shows
the company is not keeping products on a shelf for too long, which cost money
to keep them there.
receivable turnover: measures how many times a company is
able to turn its account receivables into cash. Higher is better because it
means the company is able to collect its money fast.
collection period: measures how many times a company is
able to get back money from customers who bought items on account. It’s
calculated by dividing 365 days by account receivable turnover.
Not all of them makes sense to compare companies
across different industries. This is because companies like Walmart will have a
higher inventory turnover since most of the items sold are lower in prices, and
are necessity goods. Mattress warehouses will not turnover their inventory as
fast as retails since people don’t need a new mattress everyday. Same applies
to days in inventory, account receivable turnover, and average collection
period because most groceries businesses collect payments immediate, so there’s
no account receivable to be collected or turnover. Current ratio and working
capital make sense to compare across different industries because every company
have liabilities that must be paid.
Current ratio, and working capital gives
us an idea of how efficiently a company operates because it shows how well a
company can pay its liabilities. It tells investors whether to invest in the
The profitability ratios show
a company’s ability to generate money. Some of the key profitability ratios:
measures in percentage how much is left once cost of goods sold are paid. This
is a good efficiency indicator because it tells the company how well its assets
are being used to make money
margin: measures in percentage how much net income is
generated from each net sale. Its calculated by dividing net income by net
sales. This is also a great efficiency indicator because a high profit margin
means the company can easily pay off expenses while still being able to have
money left for more activities.
on assets: compares net incomes to average total assets. Higher
turnover: measures how efficiently a compare is able to use its
Gross profit rate, assets turnover and
profit margin are a good efficiency indicator because they all show how well a
company is generating money by using its assets wisely. All three can be used
to compare companies across industries because every company has to generate
revenue by using up assets.
Payout ratio and return on common stockholder’s
equity are harder to compare across industries since each company declares
Answer word count: 189
Solvency ratios measures a company’s ability to take
care of long-term liabilities. Some of the key ratios are:
to assets ratio: measures how much of a company’s assets
is borrowed. Lower is better because it means the company is able to take care
of itself without relying on outside sources.
interest earned: measures the company’s ability to pay its
cash flow: shows how much cash is left once net cash has been subtracted
from capital expenditures and cash dividends.
All three can easily be compared across
industries because almost every company borrows money at some point, and has to
pay back, including interest. And debt to asset is the best ratio to measure efficiency
because if a company is able to generate enough profit from operations, then it
shouldn’t have to borrow money. If a company’s debt to asset is too high, then
it means creditors can easily seize assets.
Answer word count: 155